Monday, December 29, 2014

Andurand Capital's Outlook on Oil

Randy Smith’s Alden Global Capital has been betting against the ruble for the past month and a half. Yesterday, it paid off when Russia’s currency fell as much as 19 percent.

Alden, a $1.8 billion New York-based hedge fund firm, is emerging as one of the winners from a recent spike in geopolitical turmoil.Pierre Andurand, who foresaw the oil market’s peak in 2008, made an 18 percent gain for his hedge fund in November by predicting OPEC’s refusal to cut crude production and how that would strengthen the U.S. dollar against other currencies, including the Japanese yen, according to a letter to clients, a copy of which was obtained by Bloomberg News. Warren Naphtal’s $3.9 billion currency fund is up about 24 percent this year after recent bets on a stronger dollar, according to an investor report.

The hedge funds are making money from the trades at a time when many competitors are struggling to eke out a profit. This year’s more than 40 percent decline in oil prices has curbed global growth and hobbled Russia’s economy. Bill Gross, who ran the world’s largest bond fund at Pacific Investment Management Co. before joining Janus Capital Group Inc. in September, said an excess of leverage, or borrowed money, is making markets more volatile.

“When levered money moves and tries to seek a safe haven basically you have violent price movements,” Gross said in a Dec. 12 Bloomberg Surveillance interview with Tom Keene.

Emerging Markets

A $3.3 billion fund at Gross’s former firm has been one of those hit. The Pimco Emerging Markets Bond Fund (PEBIX) held $803 million of Russian corporate and sovereign bonds at the end of September, equal to 21 percent of total assets, an amount that’s more than double that of the benchmark it tracks, according to data compiled by Bloomberg. The fund has lost 7.9 percent in the past month, trailing 95 percent of its peers.

Alden, in addition to betting against the ruble, has also been profiting from a decline in Russian stock indexes, said two people familiar with the trades, who asked not to be identified because the information is private. Russian equities are down 42 percent in the past month and a half, according to the dollar-denominated RTS Index. (RTSI$)

Andurand, the 37-year-old London hedge fund manager, said earlier this month Brent crude will continue its collapse into next year as the Organization of Petroleum Exporting Countries stops balancing the global market. His firm’s bearish stance on oil in October helped his fund reverse losses in 2014 after Brent slumped during the month.

Oil futures continued their slide today after Russia, the world’s largest crude producer, said it would refrain from cutting supply to tackle the global surplus. West Texas Intermediate dropped 2.7 percent to $54.44 a barrel in New York. Brent crude for February settlement fell 1.7 percent to $59.02 a barrel in London.

Quant Funds

Naphtal’s Boston-based P/E Investments benefited indirectly from oil’s plunge as it bet on currencies with little exposure to commodities, according to two people familiar with the matter, who asked not to be identified because the information is private. The firm’s main fund, which relies on computer models to trade, rose 4 percent in November, helped by the U.S. dollar and by wagers against the Canadian and Australian dollar, the euro and the Swiss franc, according to one of the people.

The firm joins other quant funds in using computer programs to beat star managers this year, in part from the plunge in oil prices that some human traders dismissed. Hedge funds on average are trailing the Standard & Poor’s 500 Index for a sixth year. Hedge funds returned 1.7 percent this year through November, according to data compiled by Bloomberg, compared with a gain of 12 percent for the S&P 500.

OPEC's decision not to cut oil output despite a market glut gave a late-month boost to several energy hedge funds in November, pushing them toward double-digit gains in a year marked by commodity fund closures.

Greenwich, Connecticut-based Taylor Woods Capital Management, one of the larger U.S. energy hedge funds with nearly $1 billion under management, gained more than 5 percent last month and is up over 10 percent on the year, according to sources familiar with the firm's returns.

The fund, run by ex-Credit Suisse traders George "Beau" Taylor and Trevor Woods, runs a diversified energy-related portfolio, but the slump in oil prices to five-year lows after the OPEC meeting was a key driver, the sources said.

Pierre Andurand, founder of the BlueGold fund that had gigantic gains during the 2008 oil market slump, made 18 percent last month at his $350 million London-based Andurand Capital Management, which bet correctly on a dive in oil prices after the OPEC decision, the sources said. The November run extended the fund's annual gain to around 20 percent.

Crude oil prices have tumbled about 40 percent since June, the slump accelerating after the Organization of the Petroleum Exporting Countries decided last month not to cut production in spite of an oversupplied market - a decision that followed weeks of furious speculation and uncertainty in the market.

"Not everyone dared to put on heavy positions because no one really was sure what OPEC was going to do," said Tariq Zahir, managing member at Tyche Capital Advisors, a small-sized commodity trading firm in Hollow Way, New York. Tyche exited its crude oil positions prior to the meeting.

Andurand Capital could not be reached for comment. Taylor Woods declined comment.

Prior to November, Andurand Capital was up just about 2 percent on the year, according to the "The Nelson Report" on hedge fund performances, compiled by futures broker Newedge.

The Nelson Report's list of other well-known commodity funds that also trade energy and with annual gains through October includes the $1.3 billion SummerHaven Commodity Absolute Return Fund in Stamford, Connecticut, which rose 7 percent, and the $200 million Merchant Commodities Fund in Singapore, which was up 27 percent.

Those were rare bright spots in a commodity fund industry that's been steadily shrinking for several years.

Funds going out of business this year include Houston-based AAA Capital Management Advisors, which will shut its doors and return investor money by the year-end after lackluster returns. The fund, at its peak, managed more than $2 billion, but now has less than $540 million under management.

Brevan Howard, one of the world's biggest hedge fund managers, is closing its $630 million commodities fund, which was down about 4 percent through October, a source familiar with the matter said on Monday.

Over the weekend, I had a chance to exchange emails with Pierre Andurand, founder of Andurand Capital Management to discuss his market views. You will recall I discussed Andurand Capital when I reviewed Kate Kelly's book, The Secret Club That Runs the Word and in a follow-up comment where Andurand Capital responded to its critics, setting the record straight on its net performance and some of the wild claims made in Kelly's book.

My sources tell me Andurand Capital is up 14% net in December, bringing the YTD net performance to +36% and assets under management are now around $400 million. Moreover, BlueGold Legacy investors are up 25% in 2013 and 44% in 2014 to date (+33% net annualized since 2008).

In early October, Andurand Capital correctly predicted that it was highly likely OPEC would not cut or cut just a little amount, and that Brent would finish the year 2014 at $60 a barrel, and go down to $50 a barrel in Q1.

I asked Pierre Andurand to share his market views with my readers. He responded:

I think Brent will trade down to $50/bl in q1 2015 and WTI down to $45/bl. After that we should be in a $50-$60 range for 6 months or so, and then go back up in 2016 to $70-80.

The oil markets were very stable between early 2011 and mid 2014 because the growth in US shale oil production was exactly offset by an equal amount of supply disruptions. This gave a false sense of security and balance to the market but it was actually just a coincidence.

Since summer 2014, we have had less supply disruptions (some oil come back from Libya and Iran, and even Iraq), while US supply growth stayed unabated, and demand growth ended up being much weaker than the market expected (700kbd vs 1.4mbd expected earlier in the year). All that moved the global S&D by 2mbd for 2h14 and 2015. The oil market suddenly got 2mbd oversupplied for 2015, and likely to start 2015 with high inventories.

That led to prices going down to rebalance the market as there is not enough storage capacity for inventories to rise 2mbd for more than 4-6 months. In the past, every time the market would get oversupplied Saudis/OPEC would reduce production to support prices, which brought a rising floor on prices (except late 2008/early 2009 because of the severity of the financial crisis). This time the Saudis decided for the first time since 1986 to defend its market share instead of prices with a view that the swing producers should now be the high-costs producers (Pre-Salt Brazil, Canada tar sands, US Shale oil etc).

Indeed in 2008, OPEC thought they would be producing 38mbd in 2014, and in reality because of lower demand growth than expected, and higher supply growth from non OPEC, OPEC ended up producing only 30mbd in 2014. The Saudis understood that it was a lost battle to support prices every time, as it would only encourage sub-trend demand growth, and high non OPEC supply growth at the expense of their own market share. Saudis/OPEC retreating from being the swing producer means much lower prices first in an oversupplied market, and then more volatile prices. We will see very large price ranges for oil prices, which will have an effect on many other financial assets too.

Much lower prices will slow down non OPEC production growth dramatically over time (but it will take some time and will be path dependant), and will lead to bankruptcies in the less efficient producers, and the most levered ones, it will bring a lot of M&A activity in the sector, and will put a lot of pressure on countries that are major oil exporters. I believe it will be a very eventful roller coaster.

It is interesting to note that speculative length hasn’t gone down since August but has actually gone up (in number of contracts), which means that the move down came mainly from more producer hedging, and more inventory hedging. When inventories go up, this lead to more selling of futures to lock in the contango. Specs don’t need to sell or sell more for prices to go down. I think if anything too many people are trying to play the eventual rebound way too early.

I then followed up with some questions and comments and Pierre was kind enough to respond (his response is in red):

You feel WTI might briefly go below $50, then stabilize around $50-$60 a barrel in 2015 and then eventually move higher to $70-$80 a barrel in 2016 but you do mention that demand growth has been weaker than expected. My own macro thesis has been that outside the US, global growth is much weaker than expected, and this can be a source of concern as the US dollar keeps rising, weighing down commodity prices and bringing global disinflationary/ deflationary headwinds to the US via import prices. If this happens, won't oil and other commodity prices stay low for many years? Brent going down to $50. I think WTI will be a few dollars less, ie $45. I agree with you that USD will likely get stronger and will create headwinds for oil demand and economic growth outside the US. Also as many emerging countries are abandoning price subsidies in energy, the demand response of lower prices will not be as large as people might expect. But I also think lower prices will have an impact on supply growth (much lower), and potentially bring revolution and destabilization in large oil exporting countries, and that will reduce supply, bringing higher prices back eventually.

Of course, if US growth keeps moving along at a nice clip and lifts the global economy out of its stagnation, then oil and commodity prices can rebound fairly quickly but I'm not sure this will happen as the euro zone, Japan, and China are slowing down considerably and seem to be stuck in a long period of deflation/ stagnation. Yes my thesis is not that much based on demand. I do believe lower prices will bring some incremental demand back as there will be less need for biofuels, alternatives, efficient engines, and people will go back to big cars consuming large amounts of gasoline, and also because overall I think it benefits world GDP growth. So I do think overall demand growth will be higher than for 2014, but probably lower than the average of the last 10 years. That’s why I am coming up with 1mbd demand growth worldwide over the next few years.

In my opinion, the Saudis didn't want to cut supply because they are worried about global growth and future earnings. High oil prices act as a tax on consumers so by holding production steady and lowering oil prices, they are effectively helping central banks ease financial conditions around the world. Any thoughts on this? Yes it is true and part of the equation (bringing oil demand growth back up). But they are also trying to lower supply growth in order to have higher prices later.

You are correct that much lower oil prices will slow down non OPEC production dramatically over time but you mention it's "path dependent". Can you elaborate on this? Here I mean the lower prices go, the higher they will go later. If they don’t go down enough, they will stay “low” for longer.

You see more volatility in oil prices going forward which will affect other financial assets (stocks and corporate bonds). I wrote a comment about howthe plunge in oil won't crash markets but others think otherwise. Where do you stand on this? Will markets decouple from oil prices in 2015 or will a further decline in oil "shock" markets into another crash? I do not have a strong view on that… It’s always hard to predict domino effects, so the best is just to be aware of the potential. Would a panic in energy high-yield bonds spread to all high-yield bonds? Will selling in oil exporting emerging markets spread to all emerging markets? Etc. I think that large moves in oil already have a direct impact on many currencies and will be the largest cause of currencies moves (RUB, Nigeria, Norway etc obviously, but also JPY, EUR because of the impact on inflation and the response of Central Banks). Same for emerging market equities. And it will also have an impact on certain high yield bonds. It will also obviously have an impact on companies that are oil price sensitive (producers, consumers, services, etc).

I do not know yet if oil prices going down will crash markets. And that is where it is path dependent too. Lower prices are overall good for economic growth and risk assets in general as it puts more money in the hands of consumers who will spend it and support economic growth. But if oil prices crash too much, maybe it could have a negative psychological impact, and also lead to large oil exporting countries getting destabilized eventually? I do not think equity markets will crash next year because of oil. But maybe a large oil price move might force people out of their complacency?

Also less petrodollars in the system will lead to less buying of financial assets than the last few years from the Gulf and Russia, and even selling of financial assets in order to raise cash to pay for budget deficits. This could have an impact on risk assets in general.

On the balance though, I think lower oil prices are good for economic growth, and supportive of equities markets in general.

Your discussion on specs and hedgers is fascinating and I think you're right, many hedgers are trying to play the rebound too early. I remember Continental Resources CEO, Harold Hamm, was so sure oil prices would rebound fast that he publicly stated he wasn't hedging any longer. His stock kept plummeting after that along with those of other energy companies, especially oil drillers. I think hedgers had to hedge more and Hamm was the exception, and maybe since was forced to hedge recently? Banks must have pressured shale oil producers to hedge more in order to keep their loans. Specs have been net buying over the last 3 months! Too many are trying to play the rebound too early.

T. Boone Pickens came out recently predicting the return of $100 a barrel in the next 12 to 18 months, stating OPEC will slash production in the first half of 2015. He also stated you have to look at rig counts to predict oil prices. Do you use this metric as a forecasting tool? I don’t think OPEC will slash production. Saudis’ message is very clear and they can withstand the storm. It is wishful thinking from him. Yes I look at rig counts, and clearly lower prices will slow down production growth in US and Canada first, and everywhere else eventually. So far I only see vertical rig counts going down, which do not have too much impact on production growth. I think much lower oil prices will plant the seeds for the next big bull run, but I think it will be for 2017-2018. Eventually by 2018-2019 I think prices could make new all-time high. That is why I am optimistic about trading opportunities in oil markets, as there will be more volatility and larger moves than in the past thanks to OPEC letting prices balance the market.

Lastly, how would you respond to skeptical potential clients who think that you can't maintain or repeat your performance? I do not see why it will be hard or impossible to repeat it. My returns in 2014 were close to my average returns of the last 10 years. And I think there will be large moves in the next 10 years that will bring many opportunities. There will always be opportunities in the oil market. They cannot be stable for very long.

I thank Pierre Andurand for sharing his market views and as I stated in my comment when Andurand Capital responded to its critics, even though I foresee challenging times ahead for most commodity funds, investors shouldn't ignore active commodity managers, "especially ones like Andurand who have a proven track record in printing money."

My exchange with Pierre Andurand showed me a different perspective than that portrayed in Kate Kelly's book. I find him highly intelligent, down to earth and an excellent trader who understands the oil market. He's definitely the type of manager that I would have allocated to when covering directional hedge funds at the Caisse and it's not just based solely on his performance.

Those of you looking to gain more information on Andurand Capital can contact Hakon Haugnes at hhaugnes@andurandcapital.com.

Below, Francisco Blanch, BofA Merrill Lynch Global Research, and Brian Belski, BMO Capital Markets, discuss whether it's time to buy energy sector given the disruption in Libya. I don't think it's a major turning point and would steer clear of energy stocks for the foreseeable future.

And Stephen Schork, editor and founder of The Schork Report, says the bottom on oi is unknown. "We don't know how much lower oil can go, it's similar to 2008 when we knew oil at $120, $130 and $140 made no sense, but high prices became the reason for higher prices. It's the same thing in reverse." Like I said, there will be short covering and relief rallies but the trend in the near term is lower for oil and commodity stocks in 2015.

Update: Bloomberg reports oil tumbled to the lowest level in more than five years on speculation a global supply glut that’s driven crude into a bear market will continue through the first half of 2015.

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